The Cost of Bad Finance

Monday I provided some real context for our current national debt and part of the liabilities we have to maintain this expensive and inefficient development pattern we have chosen for ourselves. For a family of four, that cost would be another mortgage, nearly $1,200 per month.

While it is impossible for most such families to ponder actually taking on that burden, the number itself is an important vehicle to use to understand U.S. financial policy. This is because the path we are on is destined to make that number far worse, even if we do not borrow another dollar (which of course, we will - in fact, we are trying to "stimulate" our way out of recession, printing money and setting records for annual deficits in the process).

My thirty year mortgage calculation involved the following numbers and assumptions:

Debt and Liabilities (a family's share): $222,800

Interest Rate: 5%

Term: 30 year fixed

Monthly Payment: $1,196

You can put these numbers into any online mortgage calculator to do the math for you. Look at the numbers closely and understand that the interest rate, 5%, is at all-time lows. What would happen if that number was higher? Much higher? Take a look at this graph of mortgage rates (which will reflect the cost to borrow money at all levels) over time and you will see that we have nowhere to go but up.

National Average contract Mortgage rate, 1963 to 2009

Our debt is traded on the global market and, to a large degree, is being held by the rest of the world. That means we owe China and many other countries trillions of dollars, which they have purchased because they felt that dollars were a good investment. If we do things to make the dollar less valuable, it will cease to be such a good investment.

The implications of devaluation are not something we often ponder, especially since it has not happened since the Great Depression. In day-to-day life, devaluation simply causes it to take more dollars to buy the same amount of global currency - the dollar has less buying power. I can describe this in terms of a hotel stay in London. Back in 2000, my hotel stay in London cost me the equivalent of $150 American. When I went back a few years later to the same hotel, the dollar had dropped against the British pound and, even though the price of the hotel had not changed in local currency, it now cost me the equivalent of $200 American. My dollars had less purchasing power.

Despite the rising cost of my London hotel room in dollars, there is a push in the United States to devalue the currency. Why? Mainly because it makes exports stronger. With a devalued currency, the London hotel room would be more expensive for us, but the American manufactured computer or the American grown ear of corn would be less expensive to the rest of the world. Lower cost means more demand and we wake up to find ourselves as China.

Devaluing the currency would also reduce our debt, in global terms. Think of it in this way: If a barrel of oil cost $50 US, then our currency was devalued by half, it would now cost $100 US. For the rest of the world, that barrel of oil still cost the same. If a foreign country then were going to use the money we owed them to buy oil, even though the price of oil has not changed, they can now buy only half as much. And just like magic, in global terms we owe less (or more precisely, those countries that own our debt own less - we still owe it in terms of US Dollars, it is just not worth as much).

Deflating the currency would make holding U.S. dollars much less attractive. And, if the dollar is less desirable, it will take a higher interest rate to entice people to buy our debt, which we repay in the less desirable dollars. There are already calls to make this happen:

Economists believe the market rebellion against the dollar will spread until Bernanke starts raising interest rates from around zero to the high single digits, and pulls back the flood of currency spewed from US printing presses.

"That's a cure, but it's also going to stifle any US economic growth," said Schiff. "The economy is addicted to the cheap interest and liquidity."

Economists warn that a jump in rates will clobber stocks and cripple the already stalled housing market.

"Bernanke's other choice is to keep rates at zero, print even more money and sell more debt, but we'll see triple-digit inflation that could collapse the economy as we know it.

"The stimulus is what's toxic -- we're poisoning ourselves and the global economy with it."

So in light of this, reexamine my thirty year debt calculation with a much higher interest rate that reflects a devalued currency:

Debt and Liabilities (a family's share): $222,800

Interest Rate: 12%

Term: 30 year fixed

Monthly Payment: $2,292

Even if dollar devaluation does not become U.S. policy, it may happen anyway. The Federal reserve printing money by the hundreds of billions to keep us out of financial collapse is a short-term solution with long-term consequences in inflationary pressure. Steep interest rates hikes are the only remedy. Record deficit spending - spending money we don't have - to stimulate the economy means we are borrowing more and more, increasing the likelihood our currency will be worth less.

If you thought it was tough to make ends meet as a rich country, imagine what it will be like as an indebted, less-than-rich country. Our economic power has spared us tough choices and allowed us to live an inefficient lifestyle well beyond our means, but that power is slipping and those tough choices are more difficult now, as well as unavoidable.

If you thought an additional $1,200 per month per family to pay off our liabilities and meet our current infrastructure maintenance obligations was so unrealistic as to be laughable, try $2,300 per month. It is far past time to come to grips with how inefficient our development pattern is and our lifestyles are. It can't continue this way much longer.